Inflation Countdown in Final Stages

What it will take to get through the current mess will mean that once
it's sorted, we'll have to deal with the oncoming train of inflation, argues
Richard Lehmann of Income Securities Investor.

Our financial problems today are the result of decades of abuse of a
political system, democracy, which is conceptually flawed. The flaw is that it
elects to office those who promise the greatest number of voters the most,
irrespective of whether such promises are sustainable over time.

Greece is currently the most egregious example of a country which has spent
itself into bankruptcy. Coincidentally, it was also the first example of a
failed democracy, around 300 BC.

The fact is, our problems cannot be fixed by normal means-they are too big.
It's not just the $16 trillion in national debt, it's the $86 trillion in
unfunded government mandates. That doesn't count the trillions in similarly
unfunded state obligations.

The seeds to our economic future, however, have already been sown. The agent
of change is the Federal Reserve.

It is they, the unelected arbiters of our economic growth, who will manage
the solution of our dual burdens of trillions of dollars in national debt and
unfunded, un-payable mandates. Mandates are spending commitments for pensions,
health care, and other social programs imbedded in current legislation.

The Fed's solution, in a nutshell, is inflation. Inflation grows government
revenue without having to raise tax rates. It diminishes the burden of the
national debt and of the unfunded mandates.

Even homeowners who currently are under water on their mortgages can feel
they are on the road to recovery and will continue to make their mortgage
payments when housing prices rise. Inflation is the hidden tax that needs no
political approval. All politicians disapprove...just as they are against a weak
dollar, government waste, and special interests.

The Fed solution is a burdensome one which must be conducted in an
environment of high public visibility. Hence, a great deal of deception is
assured. The Fed has always been good at working in the dark.

Being able to do so without political accountability is essential because
their solutions, if fully understood, would not keep them in office. So far, the
Fed has been singularly unsuccessful in creating inflation despite creating
trillions in monetary reserves. This is because the de-leveraging of our economy
puts deflationary pressures on the economy.

In short, all their currency creation has only prevented a deflationary
economic spiral, a la Japan. But the Fed toolbox has a few more
hammers. They have dropped interest rates to unprecedented lows, even for
long-term borrowings.

This has the happy effect of reducing the budget deficit by billions of
dollars of annual interest expense to finance the national debt. On the other
hand, it has the unhappy effect of denying those with wealth a reasonable return
on their savings, or even a return that will preserve those savings, a de
facto wealth tax.

Don't think government is going to wait until you die before taxing your
estate. The death tax, by the way, is slated to go up to 55% from 35%. Since
returns are so low and with a death tax higher than the income tax rate,
shouldn't many consider giving away parts of their wealth early? How about that
for a way to stimulate the economy!

Low interest rates also have unintended consequences that we have still to
discover. History tells us these are almost always bad. Remember 2004-2006, when
too-low interest rates lead to a housing bubble? It can happen again, but this
time, the value increase will be driven by inflation, not inept policies or
greed. Well, maybe a little greed.

Inflation is a self-feeding economic phenomenon, so the Fed will have to act
slowly so they don't kill this golden goose. It means they will have to raise
interest rates and thereby slow growth, but not so much that it throws the
economy into a recession as Paul Volcker did in the 1980s to stop a runaway
inflation rate. Back then, though, inflation was still viewed as a problem
rather than a solution.

Inflation, of course, is a problem. It rewards debtors at the expense of
creditors. However, we live today in a world were creditors are demonized as
greedy, and debtors are the embattled middle class fighting to recover from
debts foisted on them by ruthless lenders.

Indebting oneself today is viewed as an entitlement, and doing so to excess
as a noble striving to better oneself. With luck, this attitude may change, but
meanwhile inflation is needed to give government and the profligate a new
start.

Inflation also punishes those not as economically well off, mainly the wage
earners. They will always be playing catch-up as the cost of goods rises faster
than their wages.

But then, no one said straightening out our economy wouldn't be painful. It's
just that few realize that everyone-everyone-will share the pain. You think the
last four years were hard times? Get ready for round two.

No one can put a timetable to when serious inflation will begin or what will
trigger it. Suffice to say, it will happen before President Obama leaves office.